Why Earning Income can be BAD!

After our first year of retirement I have discovered that having income can be bad.  When we retired, we transitioned from having a regular earned income from our jobs to having no earned income at all.  We are currently living off our savings.  I came to the realization that income was bad when we returned to the US and I filed our income taxes.  Due to the pandemic, our plans to drive to South America have been indefinitely postponed so we returned to the US with the intention of touring America for the summer and seeing how things go in the winter.  Before we had left the US, I had purchased international health insurance policy that excluded the US because it was much less expensive.  Upon return to the US, I cancelled the international health insurance and started shopping for US health insurance and the first place I checked was the Healthcare.gov website.

There I discovered that even though we had substantial assets but had very little income we qualified for a very generous health insurance subsidy which completely covered our health insurance premium.  The subsidy qualifications are based solely on income, not assets.  Having income is actually a disadvantage.

Take for example the recent $600 and $1,400 Covid relief payments.  You can be a Billionaire and get that money as long as your yearly income is less than $150,000 for a married couple.  So theoretically, Warren Buffett would be able to qualify for a payment since he has a yearly salary of $100,000 and most of his billions is in Berkshire Hathaway stock which pays no dividends.  Meanwhile a regular couple who makes $200,000 a year combined at their jobs would not qualify and get no money.  Social Security is another example. It doesn’t matter how much money you have, as long as your income is low enough you would escape being taxed on your social security payments.  Rich individual A has a few million dollars in ROTH IRA accounts, withdraws a $100,000 a year to fund his relaxing lifestyle would pay no taxes on his Social Security benefits.  Poor individual B with no savings is still working a job earning $34,001 when he starts taking his social security.  He would be taxed on 85% of his Social Security benefits.  A similar thing happens with Medicare.  The lesson is clear.  Having money is much better than earning money.

Of course not having any earned income can have some disadvantages, particularly when borrowing money for something like buying a car or house.  But on the other hand if you have the money you could just outright buy what you want.  Also, having some earned income, say $10,000 per person is beneficial as you would be able to claim certain tax credits such as the Earned Income tax credit.

Since we achieved FIRE I am in total control of our income.  I can decide to work a little or as much as I want, earning as much as I want. However, as we already have as much money as we need and earning a little bit more money would not change our circumstances much there is little incentive to earn a little income.  Currently our money is earning more money than I did when I was working full time.  Remember FIRE is not about never working again, but not NEEDING to work to pay your bills.  It is about the ability to do or work at what you find enjoyable rather than just what pays the bills.

As for our assets, I can put our money into bonds or treasures which pay very little income or into other investments that generate higher dividends or I can invest our money into stocks that pay no dividends like Berkshire Hathaway (BRK).  Since BRK does not pay dividends I have no income and should I need money I can sell some of my BRK stock at a long term capital gain rate.  Since I have held the stock for over a year and have very little income I would not even have to pay capital gains tax meaning I can reap all the gain on my stock assuming I stay under a certain limit.  I can also put all of my dividend paying stocks are in tax sheltered accounts like IRAs or Roth IRAs so that income does not count.  I can control exactly when and how much I roll over from my IRA to my Roth IRA for my maximum benefit.  Later on when I withdraw money from my ROTH it would not count as income.  Currently I have all interest and dividend earning assets such as S&P500 funds in tax-sheltered accounts and non-dividend earning and tax free assets such as municipal bonds in our normal taxable accounts.  This allows me to maximize our tax-free IRA to ROTH IRA conversions.

I have been thinking about the subject of earned income for a while now and it seems to me that the US tax system penalizes honestly working for your money.  Those that have little or no earned income pay little or no tax.  Those that earn money without working such as through the stock market pay a maximum long term capital gains tax of 20% and that that is only if you have more than $440,000 gain.  Otherwise it is either 0% or 15%.  If you earn that same $440,000 from a job, say as a doctor or lawyer you would pay an effective Federal tax rate of about 32% instead of a 15% for long term capital gains.  If a single person earns more than around $40,000 a year working a job he would be paying a higher marginal tax rate (22%) than a Billionaire like Warren Buffett (20%) gaining billions of dollars selling stocks.  Warren Buffett famously noted that he pays a lower percentage of his income in taxes than his secretary does. 

There is no doubt an honest job is a sucker’s game and the hidden benefit of obtaining FIRE is that you can escape the rat race.  When planning for FIRE don’t forget the hidden tax benefits you may get after you stop working.  For example if your job pays you $40,000 as a single person now, your effective Federal tax rate would be around 15% including FICA meaning you have a take home pay of around $33,000.  If instead of working for your money, you were getting a gain of $40,000 a year selling accumulated long term stocks your tax rate would be 0%.  So to replace the amount of income you earned working you would not need $1,000,000 at a 4% withdrawal rate for $40,000 a year, you would only need $825,000 at a 4% withdrawal rate for $33,000 a year assuming that all your income was from long term capital gains.  You would not be replacing an income of $40,000, you only need to replace your after tax income of $33,000.  It gets even better depending on if you have to contribute to your employer sponsored health plan since you might be able to get subsidized government health insurance for free.   You may be able to FIRE faster than you think.






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